Downtown apartment rents fall in fourth quarter

(Crain's) -- Landlords still have the upper hand over tenants in the downtown Chicago apartment market, but they lost some leverage in the fourth quarter, a trend that could continue in 2008.

(Crain's) -- Landlords still have the upper hand over tenants in the downtown Chicago apartment market, but they lost some leverage in the fourth quarter, a trend that could continue in 2008.

After factoring in concessions like free rent, rents at downtown Class A apartment buildings fell 4.3% in the fourth quarter from the third, the largest quarterly decline since 2001, according to a report by Appraisal Research Counselors. Occupancies dropped to 91.3% from 94.6% in the third quarter, the Chicago-based real estate consulting firm says.

It's too early to say the market has peaked after a three-year boom, but the outlook for landlords is increasingly murky amid a faltering economy and competition from new apartment buildings and investor-owned condominiums.

"It's certainly going to be a year of options for renters," says Appraisal Research Vice-president Ron DeVries.

Job growth, a key driver of rental demand, continues to slow: Moody's Economy.com predicts that the Chicago area will gain just 22,000 jobs this year, down from 36,800 in 2007.

On the supply side, downtown developers will complete 1,676 new apartments this year, a record, with another 2,509 set to open in 2009, according to Appraisal Research.

Landlords will face more competition from the so-called shadow rental market: condominiums that are rented out rather than occupied by their owners. Condo developers will complete a record 5,900 units this year, and many will wind up as shadow rentals.

"With the record-setting 1,676 units coming on-line in 2008, the rise in condo rentals expected with record condo deliveries in 2006, as well as the weakening job market, absorption of new (apartment) units and maintaining net effective rents will certainly be a challenge," the Appraisal Research report says.

More landlords relied on concessions to attract tenants in the fourth quarter, incentives that had all but disappeared amid the booming market of the past few years. As a result, effective Class A rents, which include concessions, fell to $2.25 a square foot in the fourth quarter, a 4.3% drop from $2.35 in the third.

Effective rents were still 2.3% higher than they were in fourth-quarter 2006, and Mr. DeVries of Appraisal Research expects similar rent gains this year. He adds that more landlords are passing utility costs along to tenants, effectively raising their rent.

Though the condo glut is a negative, it has a flip side, too: Many would-be condo buyers are sitting on the sidelines waiting for prices to fall and renting out apartments in the meantime.

Moreover, the increase in apartment supply isn't as bad as it seems, says Walter Rebenson, vice-president of development for AvalonBay Communities Inc., a Washington D.C.-based apartment investor that plans to start construction this year on a 1,000-unit apartment development in the South Loop.

While record numbers of apartments will open this year and next, the new units largely replace apartments that disappeared from the market the past several years when developers converted them to condos, he says.

Still, the economy will remain the biggest factor determining the direction of the market, Mr. Rebenson says.

"The R-word is what's got everyone worried," he says. "If we go into a recession, all bets are off."